With the FOMC meeting scheduled for next Tuesday, December 15, and the announcement of a possible rate hike on 2016 on Wednesday, we are seeing inflated volatility levels across equity markets.
VIX (spot) is currently 21.65, whereas the Russell 2000 Volatility Index (RVX) is 22.33.
Next week is also expiry, further heightening volatility levels. The at-the-money SPX Dec 2025 Straddle is priced 53.05, implying a move of about 2.6 percent between now and next Friday’s expiration. The RUT Dec 1135 Straddle is priced at 30.75 and implying a move of around 2.7 percent in the next week. Both straddles are implying moves over twice what we are accustomed to seeing for this same time period.
Despite all this speculation, we haven’t seen many big block trades this week going into the announcement, leading me to believe institutional money is waiting by the sidelines to get a better direction of what the Fed’s policy will be in 2016.
Traditionally higher rates make equity markets less attractive to investors, however, with next week’s possible rate hike tied to the Fed’s perception of the underlying strength of the US economy this is not necessarily the case.
In light of Yellen’s extremely hawkish comments, I think it is likely the Fed will announce a decision to raise rates (probably by 25 basis points).
As with any catalyst event - particularly one watched as closely as next week’s Fed announcement - I’m wary a of volatility crush once the news has been released.
For this reason, I don’t want to be long any premium, but instead want to give myself an opportunity to capture profit from inflated volatility levels.
Selling a straddle via an Iron Butterfly would allow me to control my risk, but this trade can be a commission killer for some traders.
I also have a directional bias to the upside, so I will look to sell a Bull Put Spread.
My Trade: Sell the RUT Dec 1125-1120 Bull Put Spread for $1.75
Risk: $325 per 1 Lot
Reward: $175 per 1 Lot